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CMA Intermediate · Financial Accounting · Lease Accounting

Sundaram Textiles leases a machine from Kaveri Finance Ltd. The lease term covers the major part of the machine's economic life, and title does not pass to the lessee at the end. How should the lease be classified?

It is normally a finance lease. AS 19 states that a lease term covering the major part of the asset's economic life normally indicates a finance lease even when title is not transferred, because the lessee then bears substantially all the risks and rewards of ownership.

  1. AOperating lease, because title does not pass
  2. BOperating lease, because the lessee does not pay the purchase price
  3. CFinance lease, because a lease term for the major part of the economic life normally leads to finance lease classification even if title is not transferredCorrect
  4. DCannot be a finance lease unless a purchase option exists

Explanation

AS 19 lists a lease term for the major part of the asset's economic life, even if title is not transferred, as a situation that would normally lead to finance lease classification. Absence of title transfer or of a purchase option therefore does not make it an operating lease.

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